capital budgeting, Financial Management

Serene Hall ?? AssignmentAs a consequence of the high levels of stress being recorded in the UK, and a general shifttowards a healthier more relaxed lifestyle, as an essential ingredient for good health. Not tomention the vanity levels of both men and women shooting through the roof. The Health andBeauty sector in the leisure industry is sitting comfortably, but not without severe competition,enjoying increasing profits, as the population becomes more and more health and appearanceconscious.

Today’s hectic lifestyle most certainly requires an antidote to replenish the mind &soul”This is the focus of Serene Hall, a health spa resort located in the centre of England.Serene Hall enjoys the grandeur of a large stately home, enveloped in the heart of theStaffordshire countryside. This magnificent building was built by Sir Miles Taylor, for his wifeSerene Taylor around 1808. It has remained in the Taylor family ever since. This elegantresidence has been diligently resurrected many years ago, to capture and relinquish itsoriginal aura and kudos. Thus creating the perfect ambience for the premier health spa it hasbecome today.The spa provides for a variety of clientele, offering top of the range services in an attempt tode-stress, relax and revitalise their customers. Services / facilities offered range from aneffortless stroll around the stupendous grounds, offering, even today the well maintained,refreshing wood forest walks, to the more rigorous work out’s in the Gym, naturally equipped with state of the art machinery. Dining and wining facilities leave nothing to bedesired for. And if all you want is to be pampered, then the list of treatments from which youcan choose is endless.The resurrection of Serene Hall has been supported in the main by generations of the Taylorfamily. Who also hold the largest grouping of shares and a £50 million cash injection from theHat west merchant bank, who have a 25% shareholding in the company. The managementteam consists of the Managing Director, Marketing Director, Finance Director and OperationsDirector. Three other directors have joined recently within the last five years, with a promise of15% bonuses over the next 5 years. These are to be based on the Return on Investment andprofit growth figures. The company has grown quickly, mainly due to family ownership keepingcosts tightly under control. The growth in this industry, despite a general downturn in theeconomy as a whole, has only helped facilitate the profits of Serene Hall. So much so thatSerene Hall is now operating with a full order book and little if any slack. Ironically themanagement are beginning to worry about the stress levels of their own staff. In light of thischange in market demand, which has crept up on Serene Hall almost unnoticed, the companydecided to undergo a strategic analysis exercise. It evolved that the company is in need ofmaking some strategic decisions in order to cope with and manage the intensity of the loomingcompetition and the escalating demand of this type of facility. The findings of the strategicanalysis have left Serene Hall reviewing its current strategic position with a view to the wayforward. What the team appears to be sure of is their desire to ascertain and guide thecompany to Plc status within the next two years. The team wants to sustain growth andstrengthen its market share. The Finance director is uncomfortable with the debt levels, “ Weneed to bring down our debt, so that we can keep back our profits for investment. The Marketing director offers an alternative approach, “we could market ourselves better to boost profits, after all the demand is out there” “No no... the idea is that we avoid expense not increase it” The operations Director joins the discussion “ But why are you so worried about our debt, profits are fine , the order book is full we couldn’t possibly take on any more customers anyway. Soon our own masseurs will be needing a full body massage and one of thoserelaxing head jobs, or whatever they are then we really be in trouble. The Financedirector takes a deep sigh ?? lunges his elbows onto the huge desk before him and attempts tolunges his elbows onto the huge desk before him and attempts to explain “Ahhh if we don’t manage the debt situation now, we will suffer in the long run especially when we get Plc status. Share holders don’t want to hear about a full order book. Don’t forget we still have to decide how to finance NEW YOU if that’s the way we decides to go”. And so the discussion continued.

After the lengthy discussions between the board and the management team, the following 3strategies have been put forward:1. Acquire the assets of a suitable competitor(s) to strengthen the total market share.2. Invest in upgrading Serene Hall’s facilities to attract new customers and to attract new customers and to retain existing ones.3. Withdraw from the market and close the facilities.

In the case of option 1 Serene Hall would be able to increase capacity and market sharethrough the control of a major competitor. It would mean that Serene could start to expandthroughout England ?? to an already existing market. Also such an acquisition would reducethe number of competitors and thus reduce the risk of competitive margin erosion. The targetcompany New You is located in the south of England with a projected 28% of the marketshare. New You specialises in Detox treatment ?? something Serene Hall has not really gotinto seriously. However New You has not really invested enough to provide the wholepassive atmosphere that is so relished by those who are on the go, “ twenty four seven” The consolidation of Serene Hall and New You would give a projected market share of49.2%.Major features of the acquisition would involve some rationalisation of the office facilities andthe possible redundancy of some staff. Having said this there may be job / trainingopportunities if Serene Hall decide to adopt the increasingly popular Detox services providedby New You. It would be in the best interest of Serene Hall to act quickly, as the market isalready shuffling rumours of a New You ?? Old Hag merger.The second option open to Serene Hall is to invest in an upgrading exercise. Although thisoption would offer a poorer cash flow position, it is a less risky venture. As demand forsimple relaxation and beauty enhancement is rapidly increasing and at the moment demandis exceeding supply, it would seem logical for Serene Hall to expand its existing facilities.One suggestion is to convert the two old barns to the side of the Hall into rooms overlookingthe terrace and formal grounds. These can then be used to house the current detox /colonial irrigation fad. Market research is suggesting that the demand for such facilities islikely to carry on increasing over the next 10 years. This is partly linked to demographicsbeing such that, a lot of females are approaching mid-thirties and wanting to retain theirmental & physical health/beauty, by means other than surgery. Also the whole nation’s culture seems to be taking on a positive approach to a healthy and relaxing lifestyle. SereneHall is therefore well placed to satisfy market demand.

The third and final option is that of “withdrawal” from the market. This is essentially a retreat strategy in the face of competitive pressure. In order to make this an option of strength ratherthan weakness, Serene Hall could exploit its best-selling services, whilst reducing the slightlyless utilised ones. Thus closing down the hall section by section and yielding cashconsistently, however there would be closure costs to take care of. The Marketing director isin total opposition to this idea. He cannot understand how the management team can makeany economic sense of this option given that over the last 10 years the company has spentapproximately £50 million pounds on the Hall. “We will have wasted a lot of money and lose all of our loyal customers to New You”.

These strategic possibilities now require some detailed financial analysis based on thepreliminary information described in Exhibit 2.

Exhibit 2Option 1: Acquisition of New You.The purchase price is expected to be in the region of £30m - £40m now (year 0 ?? 2003) andfurther cash flow effects might include:?? Annual cash inflows from New You ?? in a range from zero up to £40m, starting from year1 to 10 inclusive.?? Cost savings on amalgamation of up to £4m in both years 1 and 2.?? Improved market prices due to the reduction in competition producing additional cashinflows of up to £10.6m annually in years 1 - 5 inclusive?? Sale of some New You assets bringing in £30m in year 1 and stock reduction bringing in£5m in year 1.?? Some expense required by Serene Hall, to complement the acquisition - £20m in year 0.

For investment purpose the “life” of the project is assumed to be 10 yrs. All the cash flowsare expected in money terms. (i.e. after allowance for inflation). The tax rate is 25% of thenet cash flows occurring in a given year and is payable at the end of the same year. In viewof the relatively risky nature of the project, the finance director of Serene Hall asserted that the “normal ” hurdle rate of 8 % should be increased to 10 %. This has however ignited somedebate amongst the management team. Some of who, considered that the effective cost ofcapital was zero since existing cash resources would be used. Quiet apart from all thesefactors, further investigations into the acquisition established that cash flows could bereduced by the following additional factors.?? Redundancy & relocation provisions (£5m in year 1)?? Other contingencies ( up to £3m annually to year 5)?? Research & Development costs are expected to be necessary at £4m in year 1 and £5min year 2.

Option 2 : Investment to upgrade facilitiesIf Serene Hall choose this option then they can benefit from an annual cash inflow of around£18m ?? starting in year 3 at the earliest. The initial investment will coast £60m, spread overthree years.Option 3: “ Withdrawal”This option would generate cash of around £63m less closure costs of £14m ?? both spreadover 3 years.

End of data!Assessment CriteriaRequirements:Serene Hall management ponder how to tackle matters given all the information at theirdisposal. A thorough appraisal should be conducted; clear guidance as to how Serene Hallshould proceed forward is necessary. A completed report must be submitted to the board by12th December 2012. However you have the flexibility to schedule meetings with themanagement team to discuss progress and clarify any anomalies.Your report must evaluate the case situation to highlight areas of concern andproblems/issues.11It should include a thorough appraisal based on the information available and provide clearguidance as to how the company should proceed.Justify the use of any financial and accounting tools and processes selected to analyse thecase situation. A defensible set of criterion should be established and used to evaluatesolutions within a decision making context that seeks to enhance organisational control andeffectiveness.